Successfully reported this slideshow.
We use your LinkedIn profile and activity data to personalize ads and to show you more relevant ads. You can change your ad preferences anytime.
Chapter 7
Earnings and Cash Flow Analysis
Slides
7-1      Fundamentals of Investments
7-2      Cash Flow is a Company’s Li...
A-56   Chapter 7



Chapter Organization
7.1    Sources of Financial Information
7.2    Financial Statements
       A. The...
Earnings and Cash Flow Analysis    A-57


7.2    Financial Statements

       Balance sheet: Accounting statement that pro...
A-58   Chapter 7


income, interest expense, and income taxes yields net income, which is also
referred to as "the bottom ...
Earnings and Cash Flow Analysis   A-59


Notice that the cash flow used above refers to operating cash flow, not the cash
...
A-60    Chapter 7


•     CFPS x P/CF

These numbers may vary greatly. It will then be the analyst's job to determine
whic...
Upcoming SlideShare
Loading in …5
×

Instructor Notes

503 views

Published on

Published in: Business, Economy & Finance
  • Be the first to comment

  • Be the first to like this

Instructor Notes

  1. 1. Chapter 7 Earnings and Cash Flow Analysis Slides 7-1 Fundamentals of Investments 7-2 Cash Flow is a Company’s Lifeblood. 7-3 Earnings and Cash Flow Analysis 7-4 Sources of Financial Information 7-5 Sources of Financial Information 7-6 Financial Statements 7-7 Financial Statements 7-8 Work the Web 7-9 The Balance Sheet 7-10 The Balance Sheet 7-11 The Balance Sheet 7-12 The Income Statement 7-13 The Income Statement 7-14 The Cash Flow Statement 7-15 The Cash Flow Statement 7-16 Performance Ratios and Price Ratios 7-17 Performance Ratios and Price Ratios 7-18 Performance Ratios and Price Ratios 7-19 Work the Web 7-20 Financial Statement Forecasting 7-21 The Pro Forma Income Statement 7-22 The Pro Forma Cash Flow Statement 7-23 The Pro Forma Balance Sheet 7-24 Projected Profitability and Price Ratios 7-25 Projected Profitability and Price Ratios 7-26 Work the Web 7-27 Adolph Coors Company Case Study 7-28 Adolph Coors Company Case Study 7-29 Adolph Coors Company Case Study 7-30 Adolph Coors Company Case Study 7-31 Adolph Coors Company Case Study 7-32 Adolph Coors Company Case Study 7-33 Adolph Coors Company Case Study 7-34 Adolph Coors Company Case Study 7-35 Chapter Review 7-36 Chapter Review
  2. 2. A-56 Chapter 7 Chapter Organization 7.1 Sources of Financial Information 7.2 Financial Statements A. The Balance Sheet B. The Income Statement C. The Cash Flow Statement D. Performance Ratios and Price Ratios 7.3 Financial Statement Forecasting A. The Pro Forma Income Statement B. The Pro Forma Cash Flow Statement C. The Pro Forma Balance Sheet D. Projected Profitability and Price Ratios 7.4 Adolph Coors Company Case Study 7.5 Summary and Conclusions Selected Web Sites  http://www.nyse.com  http://www.sec.gov  http://www.thestreet.com  http://www.uoutperform.com  http://www.investorsuniverse.com Annotated Chapter Outline 7.1 Sources of Financial Information Edgar: Electronic archive of company filings with the SEC. 10K: Annual company report filed with the SEC. 10Q: Quarterly updates of 10K reports filed with the SEC. Reliable financial information is a prerequisite to doing good financial analysis. There are many sources of financial information, including annual reports, The Wall Street Journal, and SEC information, which includes the Edgar archives. Edgar includes company 10Ks and 10Qs, as well as other financial data. The internet also provides a wealth of financial information. The Selected Web Sites, above, provide a good starting point for finding financial information on the web.
  3. 3. Earnings and Cash Flow Analysis A-57 7.2 Financial Statements Balance sheet: Accounting statement that provides a snapshot view of a company's assets and liabilities on a particular date. Income statement: Summary statement of a firm's revenues and expenses over a specific accounting period, usually a quarter or a year. Cash flow statement: Analysis of a firm's sources and uses of cash over the accounting period, summarizing operating, investing, and financing cash flows. The firm's balance sheet, income statement, and cash flow statement provide essential, interrelated information necessary for performing a financial analysis. Remind students that reading and interpreting these financial statements isn't just "accounting work," it's a requirement of any good financial analyst. A. The Balance Sheet Asset: Anything a company owns that has value. Liability: A firm's financial obligation. Equity: An ownership interest in the company. The Borg balance sheet has four major asset categories: current assets, fixed assets, investments, and other assets. It has three major liability categories: current liabilities, long-term liabilities, and other liabilities. Stockholder equity is the difference between total assets and total liabilities, and includes paid-in capital and retained earnings. The fundamental accounting identity is: Assets = Liabilities + Equity This implies that the left side of the balance sheet always equals the right side. Financial analysts also find it useful to condense a balance sheet down to its principle categories. B. The Income Statement Income: The difference between a company's revenues and expenses, used to either pay dividends to stockholders, or kept as retained earnings within the company to finance future growth. The income statement reports revenue and expenses for a corporation over a one-year (or quarter) period. Subtracting cost of goods sold and operating expenses from net sales yields operating income. Subtracting investment
  4. 4. A-58 Chapter 7 income, interest expense, and income taxes yields net income, which is also referred to as "the bottom line." Net income is apportioned to dividends and retained earnings, in fact: Net income = Dividends + Retained earnings C. The Cash Flow Statement Cash flow: Income realized in cash form. Noncash items: Income and expense items not realized in cash form. Operating cash flow: Cash generated by a firm's normal business operations. Investment cash flow: Cash flow resulting from purchases and sales of fixed assets and investments. Financing cash flow: Cash flow originating from the issuance or repurchase of securities and the payment of dividends. The cash flow statement reports the sources and uses of a firm's cash over a specified accounting period. The statement begins with net income, and adjusts it for noncash charges to obtain the operating cash flow. The next two categories of the statement include investment cash flow and financing cash flow. After adjusting for these items, the result is the firm's net cash flow during the accounting period. D. Performance Ratios and Price Ratios Return on assets (ROA): Net income stated as a percentage of total assets. Return on equity (ROE): Net income stated as a percentage of stockholder equity. The firm's profitability ratios are calculated as follows: • Gross Margin = Gross profit / Sales • Operating Margin = Operating income / Sales • ROA = Net income / Total assets • ROE = Net income / Owner’s equity The firm's per-share values are calculated as follows: • Book Value Per Share (BVPS) = Total equity / # shares outstanding • Earnings Per Share (EPS) = Net income / # shares outstanding • Cash Flow Per Share (CFPS) = Operating cash flow / # shares outstanding
  5. 5. Earnings and Cash Flow Analysis A-59 Notice that the cash flow used above refers to operating cash flow, not the cash flow from the cash flow statement. The firm's market value ratios are calculated as follows: • Price / Book (or Market / Book) = Stock price / BVPS • Price / Earnings (P/E) = Stock price / EPS • Price / Cash flow (P/CF) = Stock price / CFPS 7.3 Financial Statement Forecasting Pro forma financial statements: Statements prepared using certain assumptions about income, cash flow, and other items. Pro forma literally means according to prescribed form. To analyze the impact of possible changes, investments, or changes in sales for the firm, it is necessary to construct pro forma financial statements for the firm under various scenarios. This allows the analyst to investigate and analyze the impact of these actions. A. The Pro Forma Income Statement The pro forma income statement begins with a projection of sales, usually for more than one scenario. The analyst then works down the income statement, explaining assumptions that were made in footnotes. B. The Pro Forma Cash Flow Statement The pro forma cash flow statement is prepared using the data from the pro forma income statement. The resulting net cash flow is applied to adjust the cash account on the pro forma balance sheet. C. The Pro Forma Balance Sheet The pro forma balance sheet is created by starting with the prior year's balance sheet, and then making adjustments that are consistent with the pro forma income statement and cash flow statement. D. Projected Profitability and Price Ratios Using the pro forma statements, the analyst now calculates the relevant ratios to determine the impact of the projected changes. Using these ratios, the analyst can compute projected stock prices as described in the last chapter. Three estimates of the stock price can be obtained from: • BVPS x P/B • EPS x P/E
  6. 6. A-60 Chapter 7 • CFPS x P/CF These numbers may vary greatly. It will then be the analyst's job to determine which stock prices are the most accurate, and the least sensitive to variance in the estimates of the inputs. 7.4 Adolph Coors Company Case Study In this section, the authors provide a complete analysis using the Adolph Coors Company. Lecture Tip: To reinforce the information in this chapter, it is helpful to introduce a project or case that relates to this chapter's material. If grading is not a consideration, the project could be done individually, with each student selecting a different firm. To minimize grading, this project could be completed using teams, with each team doing a different company, or even assigning all teams the same firm. The advantage of all teams (or students) analyzing the same firm is that all the computations can be completed beforehand by the instructor, which is very helpful in answering student questions and checking the results. One way of formatting this project is to require the students to select a firm and gather the following material for the firm: annual report, 10K, Standard & Poor's report, Dunn & Bradstreet report, and ValueLine report. Note that this material can also be used for projects that relate to other chapters in the text. Using a spreadsheet, the students will prepare an income statement, balance sheet, cash flow statement, and ratio analysis for the firm. The instructor will then give instructions for a change within the firm to allow a pro forma analysis. This could be as easy as a change in sales of plus or minus ten percent. The students will use this information to prepare complete pro formas for the firm, calculate ratios, and then estimate projected stock prices for one-year hence. Since writing is very important, the students should also prepare a report that includes the following: describe what they did, provide a complete analysis of the firm, and make recommendations for the future. Of course, a one-page Executive Summary would be very beneficial. 7.5 Summary and Conclusions

×